Bond market turbulence is making it more probable that Japan’s central bank will slow or pause the unwinding of its large holdings of government debt next fiscal year, a move that could ease pressure on Prime Minister Sanae Takaichi’s ambitious spending plans.
A decision to pause would represent a notable shift in the Bank of Japan’s quantitative tightening (QT) strategy, which began in 2024 as Governor Kazuo Ueda sought to roll back a decade of exceptionally large stimulus. At its June 15-16 policy meeting, the BOJ will review a bond taper plan that runs through March next year and will set a new approach for fiscal 2027.
Officials do not expect changes to the existing taper plan at the June meeting, so attention in markets is centered on whether the BOJ will continue to reduce monthly bond purchases in fiscal 2027 or hold the current pace. There is no firm consensus inside the bank, but two sources familiar with internal deliberations said a pause in tapering is increasingly being viewed as the preferred option given ongoing uncertainty linked to the Iran war and its effect on bond markets.
As one source put it: "Markets remain volatile, so there’s no need to rush." The same source added that many market participants appear to favour maintaining the present scale of bond buying.
Market and political pressures
Some investors have begun calling for a suspension of the taper programme, a central bank survey earlier in the month showed, underscoring the difficulty the BOJ faces in shrinking its enormous stock of Japanese government bonds (JGBs). There have already been signs that the central bank might consider slowing its taper amid market uncertainty, and clearer indications could emerge next week when the BOJ publishes minutes of a May 21-22 meeting with bond market participants.
Former BOJ official Nobuyasu Atago said: "We’ve seen a pretty fast rise in bond yields, which makes it hard for investors to buy bonds. The finance ministry may be getting worried too." He added: "Given the political headwinds, I see no reason for the BOJ to keep tapering next fiscal year."
Political calculations are central to the debate. Rising long-term yields threaten to squeeze the fiscal space available for the government’s planned spending, a major concern for the administration. "What the administration wants to avoid most is rises in bond yields," one source said, describing a key constraint on the BOJ as it weighs adjustments to the taper.
Bond yields and fiscal constraints
Worries about Japan’s deteriorating public finances and accelerating inflation pushed the 10-year JGB yield to a 30-year high of 2.8% last week, bringing it close to the 3% benchmark the finance ministry used in preparing its fiscal 2026 budget. A move above 3% would increase the cost of servicing government debt and reduce room for other spending priorities.
At the same time, the BOJ’s policy on short-term interest rates could affect the taper decision. Analysts view a rise in short-term rates to 1% from the current 0.75% as a strong possibility at the June meeting. Though the central bank has maintained that its taper programme has no direct monetary policy implications, economists say that implementing a rate hike strengthens the case for slowing QT if markets are already fragile.
Mari Iwashita, executive rates strategist at Nomura Securities, argues that caution is prudent: "With the bond market so unstable, it would be natural for the BOJ to play it safe and avoid causing undue market turbulence." She forecasts a taper pause in fiscal 2027 and suggested that "a combination of a taper pause and rate hike would be a good one," because the pause would ease upward pressure on yields while a rate rise would address concerns that the central bank is lagging in tackling inflation risks.
QT mechanics and the path ahead
The BOJ has approached its QT effort cautiously. The programme that began in 2024 has gradually reduced net purchases and currently cuts monthly buying by 200 billion yen each quarter. Political headwinds have increased since Takaichi took office and pledged tax cuts and additional spending that would be financed by debt.
Even without accelerated tapering, the BOJ’s holdings will shrink over time from the natural runoff of maturing JGBs. That runoff has already trimmed the bank’s balance sheet by around 20% from a peak in late 2023, and current holdings are roughly 500 trillion yen.
Akira Otani, a former BOJ executive now serving as managing director at Goldman Sachs Japan, noted the risks of further tapering at a politically sensitive time: "When inflationary risks from the Middle East conflict and the government’s proactive fiscal policy are putting upward pressure on bond yields, proceeding with further tapering could cause political friction by pushing up yields."
Broader context
Central banks worldwide have found it challenging to shrink bloated balance sheets established through years of large-scale asset purchases. The article notes that similar difficulties are apparent in other jurisdictions, where officials confront market responses as they seek to adjust holdings accumulated to support economic recovery.
For the BOJ, the near-term calendar is consequential. The June 15-16 meeting will review the existing taper schedule through March and make decisions about fiscal 2027 plans, while minutes from the May 21-22 market participants meeting will provide additional clues next week about the bank’s assessment of market conditions and the potential path for QT.
With bond market volatility elevated, political pressure over fiscal policy growing and the prospect of a short-term rate increase on the table, the BOJ faces a complex set of trade-offs as it determines whether to slow or halt the taper in the year ahead.